Feb. 21 (Bloomberg) -- Chesapeake Energy Corp., the second-biggest U.S. natural-gas producer, completed an unprecedented
bond offering Feb. 13 that could limit returns in the event of
an asset sale, according to bond analysts from Wells Fargo & Co.
and Covenant Review.

The $1.3 billion of 6.775 percent notes due March 2019 are
callable at par for a four-month period from mid-November 2012
to mid-March 2013, after which they convert back to non-callable
bullet bonds until maturity. This is the first bond deal to
include a par call window, said John Rote, head of high-yield
syndicate at Bank of America Corp. that arranged the deal.

The company is seeking as much as $12 billion from asset
sales and joint ventures in order to pay down some of the $11.8
billion in debt on its balance sheet, according to a Feb. 13
statement. Holders of the new bonds are incurring risk related
to the sales since gains will be capped at par for that four-month period, James Spicer, a Charlotte-based high-yield analyst
at Wells Fargo, said in a telephone interview.

“If they do an asset sale for a really strong price that
improves the credit rating, then those bonds would go up in
value,” said Adam Cohen, the New York-based founder of Covenant
Review LLC, which analyzes the terms of bond offerings. “But
because those bonds can be called at par, investors may not see
that increase in value.”

The call provision gives Oklahoma City-based Chesapeake the
flexibility to conduct an asset sale during that four-month
window. The money raised through divestitures in 2012 would be
used to reduce the company’s long-term debt to no more than $9.5
billion at Dec. 31, according to the statement.

Capital Spending

The company’s capital spending has exceeded cash from
operations in every quarter since October 2003, according to
data compiled by Bloomberg. During the third quarter of 2011, as
U.S. gas prices were tumbling 16 percent, Chesapeake swelled its
net debt by 18 percent to $11.7 billion.

If the asset sale happens and Chesapeake calls back the
bonds at par, then assuming the bonds continue to trade in their
current range, the high coupon and the new-issue discount still
make the investment attractive, according to Bank of America’s
Rote.

“If the bonds don’t come out in that November to March
time frame, you’re still getting a much better return on a pure
yield basis versus a bond of similar maturity,” said Rote. “If
it does come out, it’s basically a one-year piece of paper with
an 8-percent-plus IRR, and obviously a lot of investors found
that to be attractive,” he said, referring to the internal rate
of return.

Bond Price

The bonds were sold at 98.75 cents on the dollar, reducing
proceeds for the company and boosting yield to investors. The
bonds traded at 100.06 cents on the dollar today at 8:25 a.m.
New York time, with a yield of 6.761 percent, according to
Trace, the bond-price reporting system of the Financial Industry
Regulatory Authority.

Jim Gipson, a spokesman for Chesapeake, declined to comment
on the structure of the deal. Exxon Mobil Corp. is the largest
gas producer and energy company by market value.

Chesapeake was able to take advantage of large inflows into
high-yield bonds in the month of February to complete the deal,
according to Covenant Review’s Cohen. High-yield inflows were
$2.5 billion for the week ended Feb. 3 and $2.9 billion in the
week ended Feb. 10, the highest levels of 2012, according to
data from Cambridge, Massachusetts-based research firm EPFR
Global.

Moody’s Investors Service gives Chesapeake a Ba2 corporate
family rating and Standard & Poor’s gives it a BB+ grade.

“When there are fund flows at that level for a few weeks
in a row, that money eventually has to go somewhere,” said
Cohen. “Chesapeake was smart to issue in a week where there was
a lot of money flowing into high-yield funds.”

Actively Traded

The company is one of the most actively traded names in
high-yield, with its new bond accounting for 7 percent of trades
over $1 million on Feb. 16, according to Trace. Demand for the
new securities was high enough to allow the deal to be increased
to $1.3 billion from $1 billion.

“The technical picture in the market is very strong right
now,” said Rote. “That’s helping all deals and it certainly
helped this one. It would’ve been more difficult and costly to
get a transaction like this done in a more challenging market.”

Chesapeake tends to do complicated bond issues, and
investors would rather see the company simplify its debt
structure and adopt more straightforward solutions, said Spicer.
It should now focus on cutting back capital expenditures to
combat low natural gas prices, he said.

The company has been issuing debt without normal high-yield
bond covenants for the last several years and the new bonds
don’t currently have an asset-sale covenant in place, according
to Cohen.

“Generally speaking, the contract terms are riskier for
Chesapeake than they are for a normal high-yield company,”
Cohen said. “This deal is just another example of them pushing
that envelope a little bit further.”